John Akerson's Thoughts

Business, technology and life

Higher Bars and Changing Times Require Changing Metrics

I originally called this “Higher bars, Changing Times, and how BusinessWeek misses the point of the Big Shift.”  I still think that BusinessWeek misses the point but I think the requirement for changing metrics is more important.

John Hagel III, John Seely Brown and Lang Davison wrote a wonderful paper: The Big Shift: Why it Matters.  You can read it here.  I highly recommend it. It is insightful analysis and clear original thought. That is too rare.

Late last night I read a brief description of the Big Shift paper on page 10 of the November 23, 2009 BusinessWeek. (although I could not find the article on BW’s site)  I was struck by the conclusions drawn from the “Return on Assets” chart, which BusinessWeek pulled and perhaps distorted slightly from page 12 of the 24 page “bigshiftwhyitmatters.pdf”   BusinessWeek suggested that the report, and in particular the findings on Return on Assets (ROA)      “provides fodder for those, like BusinessWeek’s Michael Mandel, who argue that the woes of the US Economy extend(s) beyond the financial sector and began showing up well before the housing bubble”

 That small chart is such a minor part of the report. (I reproduced it here from and with credit to their paper) – The paper is delightfully brilliant, but I immediately thought that the pessimistic BusinessWeek conclusion that I quoted above was mistaken, perhaps even backwards. I think that changing

Chart from "The Big Shift"

Chart from "The Big Shift"

times, and inflation, when combined with the paper’s ROA chart, suggest that our economy is very strong – amazingly strong, and extraordinarily robust and resilient.

My three points:

 1)     The rate of inflation is not trivial given a chart that goes back to 1965, and economy of scale has fundamentally shifted due to technology, and the rest of our ever-changing world.

 Adjusting for the rate of inflation wouldn’t necessarily make the Return on Assets chart look more flat – but considering an actual company, its asset value and returns, AND its changing requirements might lead to a different conclusion. 

 The Bureau of Labor Statistics’ inflation calculator: http://www.bls.gov/data/inflation_calculator.htm shows that over the time of that$1000 in 1965 = $6835.02 in 2008 chart, $1000 of 1965 dollars equates to something like $6835.02 of 2008 dollars.  Excluding the recessionary pops in the tech bubble in 01-02 and the pop in the housing bubble in 08-09… ROA looks like it is gone from just under 5% to about 2%.  Regardless of the consumer price index or the perhaps more appropriate producer price index, a percentage is a percentage – but consider a fictitious company that is making 5% ROA in 1965 with $1,000,000,000 of assets. Thats a return of $50,000,000. Adjusting for inflation using the consumer price index suggests a  company with $6,835,020,000 in assets in 2008. That company would have a return of $341,751,000 with a 5% ROA – but only a return of $136,700,400.  Is that a decline from 5% ROA? Is it a decline from $50m to $136m? (when adjusted for inflation) 

 2)     Given the advances and changes in regulations and particularly in technology – which are CLEARLY covered in the Big Shift paper – the bar is simply set higher, everywhere. Any company has higher requirements to earn sales – to get returns – to exist.  Enormous Seismic changes in business have emerged and been adopted across the entire economy. These changes initially provide competitive advantages to companies, but many are now essentially baseline requirements for doing business. These changes don’t happen without extraordinary increases in total assets.

 Take any company from 1965 – say a bank. In 1965, a bank had costs for buildings, technology, people, marketing, and processes. All of those fixed costs are now an enormous order of magnitude larger than they would have been in 1965. That bank has to be equipped, staffed, and technologically able to meet customer’s expectations in 1965 and today, but those expectations and regulatory requirements and competitive forces are orders of magnitude both greater and more complex.  In 1965, for example, checks written on the account of one bank, cashed at another bank might ordinarily take 5- 10 days to clear.  Today the float is almost always less than 24 hours, and in some cases, can be only seconds. In 1965, there were no ATM’s, online banking, online bill payment, online monthly statements. There was no Sarbanes Oxley. There were very different legal and practical considerations for interstate and truly national banks. A bank with $6b in assets, today, has vastly different requirements – and it must staff to meet those requirements.  So – if you look at that bank today, and say that it only has a 2% return on assets, that suggests a return of $136,700,400, in a world in which they have legal requirements that may include, say, keeping 7 years of electronic statements that can be accessed online instantly by their customers – and customer expectations that require them to have a thousand ATM’s, an online banking platform that is secure, scalable, and approaches or exceeds 99.99% availability. 

 This comparison extends across industries – I picked banking because I know it more intimately. (disclaimer: Since leaving Deloitte in 1999 as the Corporate Internet Technology Manager I’ve worked on Internet, Intranet and online banking elements for 3 banks via merger and acquisition.) Pick any other industry or business concern – and change has been enormous. In medicine, for example, in 1965, there was no HIPAA, no mail order pharmacies, no HMO’s, no outsourcing, no offshoring, etc. Hollywood didn’t have digital piracy, digital movie transmission, Redbox, and a cluster of cable companies waiting to first run their movies. The music industry had payola but no MP3’s or internet. Every industry has global competitive forces, global competition for talent and complete shifts. Pick almost any industry, and there are simply higher bars and different bars that companies must clear to succeed. Those higher requirements have resulted in larger asset requirements, but meeting those requirements, to me doesn’t really equate to lower efficiency.  It is a maintenance of Return on Assets regardless of changes.

 That’s critically important.

 Rather than the gloomy BusinessWeek (Michael Mandel) type-suggestion that your chart reflects underlying woes that exist in our economy – I would argue that given the changes in the economy, in customer expectations, and in government regulations, it is amazing that companies manage to meet those expectations and requirements and yet have only declined from 5% ROA to 2%. From the other perspective – the 2% ROA is delivered while meeting significantly larger competitive, organizational, regulatory requirements in essentially every business that still exists.

 3)     Companies have invested in knowledge assets that cannot be tracked on balance sheets. This is nothing new, but knowledge assets are a larger percentage of total

Growing Knowledge Assets

Growing Knowledge Assets

assets – and perhaps that means that ultimately ROA percentages have dropped even more than suggested.  The Big Shift addresses this knowledge requirement (see chart) but more importantly than mentioning it is – how can we quantify it?

 Those steeper requirements – higher bars – greater requirements – are not a symptom of an economy in woes – they are merely a reflection of changing times.  Across the economy, companies meet those requirements, grow, expand, and produce, and continue to return on assets…amazingly. Distilling it to Return on Assets can be justified, but conclusions from that distillation can’t assume “other things being equal” because the current return is based on the higher bars that changing times require.

 To quote The Big Shift

“The answer is not to find ways to squeeze creative talent and customers in a zero sum battle to capture more of the existing pie, but rather, as we will see, to discover new ways of organizing and operating to more effectively create and capture new value.”

 Michael Mandel writes in  BusinessWeek (link here)  that he “told Hagel that he didn’t want to write about his “big shift” until (he) saw industry data, so (he) could understand which industries were driving the corporate performance decline”

 Does Mr. Mandel start with the premise that there is a corporate performance decline – wanting only evidence to support that premise? I can’t tell. If declining ROA equates to declining corporate performance, he is right. I think the world has changed too much since 1965

Perhaps the big shift is also a big shift in the way that we should evaluate corporate performance metrics, and in how we define success. Should we have more capable methods for tracking knowledge assets? That will be frightening for some executives because it might entail that a company that has significantly outsourced and offshored has significantly less assets (essentially that it has lost significant assets) when compared with a similar company that has outsourced less or not at all…

What metrics could be developed to track the value of knowledge assets? should those assets be monitored, and valued in ways similar to other business assets?

To me, it is obvious that there are higher bars and changing times.  The Big Shift that John Seely Brown, Lang Davison, and John Hagel III write about – is a shift that may require changing metrics – at the very least. This Big Shift brings Big Questions…  and I believe the answers will be essential because the shift reflects a clear paradigm shift. 

What do you think? Am I right? Am I missing the point?

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November 18, 2009 - Posted by | Business, Competitive Advantage, Continuous Improvement, People, Technology

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